Japan’s largest pension fund is facing increased pressure to deliver results

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Every five years, Japan’s Government Pension Investment Fund sends a shiver of excitement through the investment community. This is one such year: when the country’s largest fund conducts a five-yearly review of its investment assumptions – covering everything from inflation to expected returns for various asset classes.

Those decisions determine the fund’s ¥246 billion ($1.6 billion) policy portfolio and how much money goes to which asset classes. It may also impact how much will go to each of the 39 external fund managers and whether that list can expand.

Established in 2006, the GPIF was established to manage a portion of Japan’s national public pension and its reserves and to create sufficient investment growth to meet the needs of the country’s rapidly aging population. Since 2014, the fund has held roughly half of its assets in equities and half in fixed income, both split between domestic and overseas holdings.

However, the idea that most of us can retire from work as we enter our mid-60s is becoming outdated. For example, Japan has the highest proportion of workers over the age of 65: at 13.6%, according to OECD data.

This group may want to keep busy or need additional income to prevent years of life from savings and any retirement income. The country also needs these workers. Japan’s total population is just over 124 million people, but shrinking: the country lost an annual average of about 550,000 citizens between 2021 and 2023, according to data from the Ministry of Internal Affairs and Communications. This meant that in the year to October 2023 the working population fell by 256,000.

Japan’s pension system is thus vital. It comprises a basic flat rate pension, an earnings-based employee pension and voluntary private pension schemes. The first two are both defined benefit plans and the last one is defined contribution. The first and largest provides a basic income to all Japanese citizens, employed or not.

“Combining these factors reveals an estimated breakdown of 48% (of retirees’ income) from the national pension, 33% from the employee pension and 19% from the corporate pension,” explains Katsutoshi Inadome, senior strategist at Sumitomo Mitsui Trust. Asset Management, one of the largest asset managers in Asia.

In 1999-2000, Japan undertook highly controversial reforms of these pension systems, designed to prepare the country for the result of a rapidly aging population and a low fertility rate of just 1.2 children per woman. Basic pension benefits were reduced and the retirement age for men was raised from 60 to 65. An effort was made to fund the national pension reserves – GPIF – using riskier assets, mainly equities.

That helped. GPIF investment performance in calendar year 2023 increased by 22.7%, the second best year on record. In part, this improvement stems from the weakening of the yen, as well as the shift of GPIF to external managers using active strategies. At the end of 2023, the fund had ¥17 billion ($121 billion) with this group and the rest with passive managers. There could be even more shifts toward active management over time.

Indeed, alternative asset managers – those who invest in assets including infrastructure, private equity and real estate – hope that the GPIF will eventually increase its holdings in this area. In March 2024, it was just under 1.5 percent. Any increase depends on the path of global interest rates. “We believe that high interest rates can reduce the benefits of leverage in alternative asset investments,” says GPIF chief investment officer Eiji Ueda.

However, despite the reforms, the Japanese system does not score highly compared to its global peers. An annual ranking of the systems of 47 countries by pension consultants Mercer, together with the CFA Institute, gave Japan a score of 56.3 out of 100. It is only good enough for a C grade – in line with Italy, China and South Korea .

The sustainability of Japan’s pension system worries Mercer’s David Knox, the report’s author. Can existing pension systems continue to deliver despite demographic and financial challenges, the report asks.

Its basic old-age pension “only meets about 18% of the national average wage,” Knox points out. “Better systems pay at least 25% and in some cases over 30% in the OECD. Australia’s level is 28% and Denmark’s is 36%.

Japan’s pension system therefore faces a daunting task, even after its reforms. GPIF’s change in investment policies to take more risks was praised. “However, it’s not about investment, it’s about general reform,” says Akiko Nomura of the Nomura Capital Markets Institute. “We should be looking at the overall system rather than just the investment side.”